Traders take a ride on the cash carousel

Bankers are making millions from the latest financial policy, says Edmund
Conway.

The shoppers in Manchester could hardly believe their luck. A cash machine was mistakenly dispensing £20 notes in place of tens. Word got around: friends and family soon arrived, and used their cards over and over. A queue snaked down the pavement until late afternoon, when the machine finally ran out of money.

As those shoppers found out that Thursday in January, nothing smells as sweet and glorious as free money. And that intoxicating scent is, against all odds, currently overpowering the money markets. After almost two years of misery, banks and hedge funds are swooping upon the financial equivalent of a monumental, incontinent cash machine. This malfunction has been going on for months and is not likely to be fixed any time soon – and it is leaking taxpayers' money straight back into the pockets of bankers.

Here's how the wheeze works: you buy some cheap bonds off the Government, swap them with other City folk, sit on them for a bit and then sell them straight back to the Bank of England – at a higher price. Voila, you pocket a tidy portion of the difference. And not only is this legal, it is actually endorsed by the Government.

Welcome to the weird world of post-crisis markets, a dysfunctional netherland where a government's butterfly wing-flap can trigger a million-pound win for a trader here, a million-pound loss for a company there. Previously, the way to make money in these kinds of markets was to slice and dice complex debt instruments, sell them on to clueless investors and pocket a fee on the way. That line of work became defunct in the early days of the financial crisis, costing banks a lot of money. But if you thought that was the end of the money-go-round, think again.

The debt carousel has been replaced by the quantitative easing quick-step, whereby traders make millions buying Government bonds (gilts) cheap and selling them high to the Bank, which is purchasing vast stretches of the gilt market to pump money back into the economy. It leaves a distinctly bad taste in the mouth, for the Bank's scheme is designed to support the economy – to safeguard jobs and prevent bankruptcies – not to line the pockets of City traders.

The Bank would rather buy gilts off non-bank investors – mainly pension funds – who are then compelled to go off and spend the proceeds on other things, such as corporate debt, which in turn helps the economy to recover. As things stand, however, the investment banks and hedge funds, who are far quicker-footed – and, let's face it, often far smarter – have stepped in and are making millions. You can criticise them, just as you can criticise those eager shoppers in Manchester who took their chance at the cashpoint. But more of the blame must surely be placed on the bank behind the malfunction.

It is lesson number one of capitalism: create a market and people will trade on it. The Bank and the Government can surely recognise the sad irony that institutions responsible for causing the economic drought have diverted the flow of healing water their own way. They must also recognise that it is a problem of their own making because, once again, they have allowed themselves to be outmanoeuvred by bankers.

The Institute for Economic Affairs published an excellent pamphlet this week diagnosing the causes of the credit crunch and its conclusion is quite simple: this was not down to a failure of markets or misbehaviour by bankers and hedge funds; the most important factor was a catastrophic failure by governments and regulators to oversee markets.

We know from bitter experience that if you set up rules and restrictions designed to restrain banks and traders from inappropriate behaviour, at least some will bend those rules as much as possible without breaking the law. This is human nature. We may disapprove, but, short of instituting a hideously inefficient command economy, there is little we can do to change it. Instead, we must rely on the Government and the regulators at the Bank of England and the Financial Services Authority to do everything in their power to stay one step ahead of the traders. One look at what is going on in the money markets shows that they are failing – again.

You can take the view that it is reassuring that financial opportunism has not died – that people are still finding innovative ways to make money. This capitalist spirit is the fuel that, properly channelled, can help power our economy ahead in the future. But the Government must not take that view, and must instead beware. Its failure to police the system properly in the past decade ultimately led to the worst economic and financial collapse in almost 80 years. If it fails to get its act together, if it fails to anticipate better the consequences of its decisions, it risks allowing the seeds of the next crisis to be sown.